Magnolia Oil & Gas Corporation — Q3 2018 Form 10-Q
Reporting period: Quarter ended September 30, 2018; filed November 13, 2018. The July 31 closing of the Business Combination created a new accounting basis. Accordingly, reported Successor results cover July 31–September 30, while Predecessor results are presented separately and are not directly comparable.
Business context and major transactions
Magnolia is a South Texas oil and gas producer focused on the Eagle Ford Shale and Austin Chalk. The July 31 Business Combination added Karnes County and Giddings assets and an approximately 35% interest in Ironwood Eagle Ford Midstream. Preliminary purchase consideration was approximately $2.812 billion, including $1.219 billion cash, $1.423 billion stock, and $169 million fair value of contingent consideration. Magnolia also acquired Harvest’s South Texas assets on August 31 for approximately $191.5 million, comprising $133.3 million cash and 4.2 million newly issued Class A shares.
Key financial metrics
| Metric | Reported Successor period (July 31–September 30) |
|---|---|
| Revenue | $178.6 million |
| Operating income | $40.7 million |
| Net income | $25.5 million, including $18.8 million attributable to noncontrolling interests |
| Net income attributable to Class A common stock | $6.7 million; diluted EPS $0.04 |
| Operating cash flow | $90.7 million |
| Investing cash flow | $(761.9) million, substantially reflecting acquisitions |
| Financing cash flow | $707.9 million |
| Cash at September 30 | $36.7 million |
| Debt | $400 million face value of 6.0% senior notes due 2026; $388.3 million net carrying value. No RBL borrowings. |
| Liquidity | Company reported over $586.7 million, including cash and the $550 million RBL borrowing base. |
| Production | 57,475 Boe/d average for the Successor period; 60 MBoe/d reported for September. |
Pro forma results, assuming the Business Combination and related transactions had occurred on January 1, provide a more comparable quarterly view: Q3 2018 revenue was $267.7 million and net income attributable to Class A common stock was $57.9 million, versus $110.3 million and $6.5 million, respectively, for Q3 2017. These unaudited pro forma figures are not a forecast and rely on assumptions.
Material changes versus prior periods
- Acquisitions substantially expanded the asset base and production footprint; September 30 holdings included approximately 14,600 net acres in Karnes County and 459,000 net acres in the Giddings Field.
- Q3 pro forma revenue and attributable net income exceeded the prior-year pro forma quarter. Management attributed growth principally to acquired assets, development and higher realized oil and NGL prices; natural gas prices were lower.
- Successor DD&A was $19.25 per Boe, versus $12.07 per Boe in the Q3 2017 Predecessor period, largely reflecting acquisition-date fair-value step-ups. The accounting-basis change limits direct comparisons.
- Successor operating expenses included $22.4 million of transaction costs and $11.0 million for a one-time seismic-license continuation. Other expense included a $6.7 million loss on settlement of the Giddings earnout.
- At September 30, Magnolia had met stock-price thresholds for two Karnes earnout tranches and issued related shares. The third tranche threshold was met October 4, with additional shares issued after quarter-end.
Outlook, risks and other notable items
- Management planned to spend within 60% of EBITDAX on drilling and completions, targeting moderate annual production growth of 10%–15%. It expected this plan to support free cash flow for acquisitions, share repurchases and debt reduction.
- The company operated three rigs in Q3 and brought 19 operated horizontal wells online. It expected to add a second Giddings rig in Q1 2019.
- Management believed cash, operating cash flow and RBL availability would cover the remainder of 2018 capital needs and short-term liquidity requirements. The RBL borrowing base was $550 million; the facility was undrawn and covenants were met.
- Magnolia had not hedged commodity exposure since inception and did not expect to hedge. Its results are therefore exposed to volatile oil, gas and NGL prices. Management estimated that a $1/bbl oil-price change would affect annualized revenue by approximately $12.1 million and a $0.10/Mcf gas-price change by approximately $3.0 million.
- Contractual commitments totaled $69.5 million for purchase obligations, operating leases and service fees, in addition to $400 million principal and estimated interest obligations on debt. The five-year EVOC services agreement carries a fixed annual fee of approximately $23.6 million and may be terminated by either party after two years.
- A Karnes County property-interest lawsuit remained in discovery; exposure was not reasonably estimable and the contributors retained the liability. Magnolia reported no accrual and did not expect ordinary-course disputes to materially affect its financial statements. Environmental insurance does not cover all risks.
- Because post-combination controls were still being designed and implemented, management could not assess the effectiveness of disclosure controls and procedures as of September 30 without unreasonable effort or expense.
Important facts for investors to verify
- Review the final purchase-price allocations and valuation assumptions for the Business Combination and Harvest acquisition; the disclosed allocations were preliminary and could change materially.
- Reconcile reported Successor and Predecessor results with the unaudited pro forma figures, and assess acquisition effects, fair-value DD&A, one-time charges and noncontrolling interests.
- Track production, realized commodity prices, operating costs and the stated 10%–15% growth plan, including the timing and economics of additional Giddings drilling.
- Monitor debt, RBL borrowing-base redeterminations, covenant headroom, acquisition and capital-spending needs, and Magnolia’s unhedged commodity-price exposure.
- Assess the impact of earnout share issuance and potential dilution, as well as execution of the EVOC services arrangement and development of post-combination financial controls.